Here’s a link to the St. Louis Fed website, where you can see a long history of the quarterly computation of M2 velocity, captured in an interactive chart: “Velocity of M2 Money Stock (M2V),” https://fred.stlouisfed.org/series/M2V. The page explains the term for readers who are not familiar with it.
For about a half century, M2 velocity seemed to be stable in the United States. Because of that long history, many came to believe that a change in the supply of money would lead to a corresponding change in inflation, and many inflation forecasts were predicated on the notion that there was a continuing relationship between the two. Velocity picked up around the end of the century and coincident with the tech stock bubble period ending in the millennium year, 2000. It has been falling since, as the chart shows.
So much for the long and predictable track record of using velocity to forecast inflation. Just as the tech stock bubble burst, so did the velocity-forecasting bubble. Velocity has been accelerating downward, and the COVID shock sent it to a new low level. We recommend readers take the time to hover over the St. Louis website chart with their cursors and see the changes in velocity and when they occurred.
Now in the financial media we see lots of rhetoric condemning the Fed because of the huge increase in M2. By definition, quantitative easing (QE) and Fed balance sheet expansion have to increase M2. And we also see lots of forecasts about a coming pick-up in velocity and a corresponding inflation warning. The other side of the argument is that inflation is currently “transitory.” Market-based pricing of inflation-indexed securities supports that transitory forecast.
But we all know that forecasting the future yields only one guaranteed result: You’re wrong the minute you make the forecast. And we also know that market-based prices are influenced by many factors and are not always reliable for forecasting. They do reflect the consensus of opinion at any given moment. Further, we know that the opinions of market agents can change rapidly, which is why those opinions are dangerous to use for forecasting.
So where do we stand on the inflation scare versus the transitory debate?
Here’s why we are on the transitory side. (And we admit up front that this is a forecast and therefore dangerous.)
COVID is a monster shock. It crunched (collapsed) aggregate demand. At this point the V-shaped upward surge has aggregate demand outpacing the resumption of supply, so the upward movement of prices is reflected in the monthly inflation numbers (temporary demand-pull inflation at work). We have to expect this: COVID administered a typical two-year shock in one month. (I’m not talking about the stock market here, but the pattern in the stock market is similar).
But once the recovery surge is over (we think by year-end), we have to then see where we are. And here is where the COVID shock really becomes apparent.
In America, about one million excess deaths are likely to be the outcome of the COVID shock. Excess deaths include those above demographic forecasts, whether they are COVID-confirmed deaths or non-COVID-confirmed deaths are included. Many (about 20%) of probable COVID deaths are not logged as COVID-related, but the number of excess deaths is what counts here, and that total is above the numbers predicted in the mortality tables. Note that mortality sans a pandemic or other shock is a very predictable figure. Just ask any life insurance company.
See, for example, this story about Florida, where the number of excess deaths in rural areas suggests that many COVID-related deaths were not designated as such: “COVID-19 has been more deadly in Florida than reported, especially in rural counties, study shows,” https://www.sun-sentinel.com/coronavirus/fl-ne-covid-deaths-florida-study-ss-prem-20210331-a4rnsenzajdd5nnwzm2fkg5g5y-story.html. Undercounts can, of course, mask the severity of the virus and impact human behavior. But whether the count of deaths caused by COVID-19 is accurate or significantly underreported in any given place, it is the number of excess deaths above the anticipated baseline that actually quantifies loss of life resulting from the pandemic period. Debates may ensue about who died of what cause, but total excess deaths remain the bottom line in terms of the economic shock we might expect as a result.
The hit is huge: In the US the pandemic has resulted in “the largest single-year surge in the death rate since federal statistics became available. The rate increased 16 percent from 2019, even more than the 12 percent jump during the 1918 flu pandemic.” (“How Covid Upended a Century of Patterns in U.S. Deaths,”
https://www.nytimes.com/interactive/2021/04/23/us/covid-19-death-toll.html)
Each of those excess deaths results in a computation of “years of life lost” (YLL). To make this estimate, researchers use the mortality tables and then observe the ages of the COVID dead and other excess dead.
That derived estimate is about 9 years of life lost for each COVID death in the US, according to this recent study: “Years of life lost associated with COVID-19 deaths in the USA during the first year of the pandemic,” https://academic.oup.com/jpubhealth/advance-article/doi/10.1093/pubmed/fdab123/6220106.
Lose someone who is 100 years old, and the contribution of lost years to the average is extremely small. Lose someone who is 30, and it is quite large. COVID has killed older folks disproportionally (although that is recently changing with variants and with anti-vaxxers’ behavior, which will only worsen the death count over time). For readers who would like to see additional studies attempting at various points in the pandemic to estimate years of life lost, we have listed several at the end of this piece for further reading.
Readers must note that this is a very new field of inquiry. So numbers will change, and estimates vary and will be refined over time. At this stage, my point is not the exact numbers; my point is the concept. The idea of using a YLL factor in estimating the recovery of demand is new for economists. We have used the mortality table for decades. Now we have to adjust to account for this massive shock wrought by a virus.
By the end of this calendar year, we project a COVID shock of about 10 million YLL in the United States. That is a huge reduction in projected aggregate demand, because consumption by those million people over their projected average 9 lost years disappears. That is an addition to the baseline projection from the mortality tables. And I haven’t even touched the issue of the skills lost. The 100-year-old person who died of COVID in a nursing home counts as a COVID death but makes only a small contribution to this economic estimate. The 30-year-old nurse who died of COVID while caring for COVID patients in a hospital, on the other hand, makes large contribution to YLL and will be sorely missed, as will the 50-year-old engineer or computer scientist. So, too, the truck driver or teacher. COVID has killed many who are highly skilled, and it has killed many who had years yet to contribute to the labor force.
So we think this large gap will take years to fill. For example, we have recently seen job growth of nearly one million in a month. And we see a plunging unemployment rate. But we also see an increasing number of long-term unemployed. And we see that the total number of nonfarm employed is back up to 143 million. But do we remember that the figure was 153 million in the month before the COVID shock? In other words, instead of growing from 153 million to 155 million, we are now back up to only 143 million, not to where we were before. In an NBER working paper in December of 2020, Francesco Bianchi, Giada Bianchi, and Dongho Song “estimate[d] the size of the COVID-19-related unemployment shock to be between 2 and 5 times larger than the typical unemployment shock, depending on race and gender” (“The Long-Term Impact of the COVID-19 Unemployment Shock on Life Expectancy and Mortality Rates, https://www.nber.org/papers/w28304).
We don’t use velocity and haven’t for years. We had never considered using YLL until the last few months. And we are working on refinements in our analysis and likely will be working on them for years to come.
One last thought.
This discussion hasn’t included the COVID long haulers, whose life-limiting symptoms linger after infection. They are a growing cohort, and we will be writing about them again soon. These are the COVID survivors with long-term medical issues, whether those are cardiac or respiratory or neurological. The evidence grows daily that there are something like six to eight long haulers for each COVID death. That loss of health and capacity, too, is a demand shock. It also impacts the ability of the labor force to work since it leads to growing medical leaves of absence and disability. It also raises the demands on the healthcare sector. Millions more COVID long haulers will need treatments and work accommodations if they are to be able to continue to contribute to the labor force.
Much more data needs to be gathered to enable us to quantify both the medical needs of COVID long haulers and a figure capturing the weeks, months, or years of work lost to long COVID; but we do have enough input to know that the numbers will be significant. For example, an international, web-based survey of COVID long haulers, published in December of 2020, found that “45.2% (42.9% to 47.2%) reported requiring a reduced work schedule compared to pre-illness, and 22.3% (20.5% to 24.3%) were not working at the time of survey due to their health conditions.” Only 23% of long haulers involved in this study were able to work as many hours as they had before COVID upended their lives. (“Characterizing Long COVID in an International Cohort: 7 Months of Symptoms and Their Impact,” https://www.medrxiv.org/content/10.1101/2020.12.24.20248802v2.full)
A November 2020 article from Personnel Today outlines the challenges for employers: “Could ‘long Covid’ become the biggest return-to-work challenge yet for OH?,” https://www.personneltoday.com/hr/could-long-covid-become-the-biggest-return-to-work-challenge-yet-for-oh/.
Work accommodations can enable many COVID long haulers to contribute to the labor force to the extent that they are able to do so. The Wall Street Journal reports on how employers and employees are working out arrangements: “The Challenges of Getting Long-Covid Patients Back to Work,” https://www.wsj.com/articles/the-challenges-of-getting-long-covid-patients-back-to-work-11613350801.
Let’s sum it up. Velocity is a nice economic concept, but it doesn't help us now, as we adjust to COVID impacts caused by excess loss of life or temporary or permanent loss of health. Fed QE reflects that the Fed understands the transitory nature of this shock, and the Fed is doing all it can with monetary tools to mitigate the damage. In our view, inflation is likely to rise and plateau and then fall. The Fed may not be able to achieve its 2%-plus target for a sustained period. There is no way to know yet just how large the COVID shock will be.
Readers can now understand why the investment side of our US stock portfolio structure is very heavily overweight the healthcare sector.
David R. Kotok
Chairman of the Board & Chief Investment Officer
Email | Bio
Additional Resources on the COVID-19 Pandemic and Years of Life Lost
“COVID-19: How Many Years of Life Lost?”
https://www.medrxiv.org/content/10.1101/2020.06.08.20050559v2
“Years of Life Lost Associated with COVID-19 Deaths in the United States During the First Year of the Pandemic,”
https://www.medrxiv.org/content/10.1101/2021.03.02.21252715v1
“Excess Deaths Overview,”
https://kieranhealy.org/blog/archives/2020/10/10/excess-deaths-overview/
“3.9 Million Years,”
https://www.vox.com/the-highlight/22300827/years-potential-life-lost-covid
“Years of life lost to COVID-19 in 81 countries,”
https://www.nature.com/articles/s41598-021-83040-3
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